The Federal Reserve launched its much-awaited FedNow real-time payments channel on July 20, and experts say it can be revolutionary for the payments industry.

The United States was lagging in the adoption of real-time payments (RTP) before the launch of FedNow because the market is structured on choice rather than mandate, Jennifer Lucas, Americas payments consulting leader at Ernst & Young, told Bank Automation News.

U.S. consumers and financial institutions have the option to adopt and implement instant payments channels, unlike in the European Union, where nearly all banks are required to provide affordable instant payment services to their EU customers, Lucas said.

Expediting real-time payments across the US

The Fed launched its instant payments service to increase real-time payments “ubiquity” in the country although The Clearing House’s RTP solution already exists, Dan Baum, senior vice president and head of payments product management for the FedNow service, told BAN.

“Because of the connections with the thousands of banks that we provide services to, we believed that we could expedite that [real-time payments adoption],” Baum said. “We could get to ubiquity, and then all boats would rise together, and we’d have the benefit of instant payments sooner in the United States.”

Prior to FedNow, the Fed was processing roughly $5 trillion in payments across a network of 10,000 financial institutions on an average day, Mark Gould, chief payments executive at the Federal Reserve, said on the Alex Johnson’s “Fintech Takes” podcast Aug. 23.

Given the size of the U.S. payments market, not having instant payments can be a hindrance for many businesses, Bridget Hall, leader of real-time payments for the Americas at Miami-based payments services provider ACI Worldwide, told BAN.

“From a competitive perspective we have one of the largest economies in the world, and we are a little bit behind from a real-time payments perspective,” Hall said. “So certainly, with the launch of FedNow, this will help the U.S. from a global perspective to have that competitive edge of being able to compete in real-time payments.”

The Fed’s Gould agrees. Total U.S. currency in cash has nearly doubled in the past decade, and the Fed cleared $9 trillion worth of checks last year, he said in last week’s podcast. The launch of FedNow will help drive the adoption of digital payments, which have steadily increased over the past few decades, he added.

Real-time payments adoption

The Clearing House (TCH) has been a major force in driving the adoption of RTP in the U.S. since November 2017 when it became the first real-time payments channel to be launched.

TCH, the oldest banking consortium in the U.S., said in July it had surpassed 500 million RTPs since its launch. The Clearing House totaled 58 million payments for $29 billion in the second quarter of this year, it announced in a July 3 release.

FedNow’s launch will only increase adoption of RTPs as many financial institutions would rather use a Fed-owned payment rail rather than a big bank consortium payment channel, EY’s Lucas said.

“Tax filings and government payments can also drive adoption of this payment channel higher,” Lucas said.

Tede Forman, president of payment solutions at Jack Henry, told BAN, “I think you’re going to see, you know, a lot of government agencies that are going to start leveraging the Fed rails specifically for doing disbursements.”

While there are multiple reasons for FedNow and its mass adoption, including P2P and B2B payments, utility payments might be the best use of the service, Hall said.

“The utility companies would love to do a request for payment so that consumers could pay them for their electrical bill, and avoid spending as much time, money, effort, reconciliation effort to resend invoices and request for payment again or apply a late fee or go through the collections process,” Hall explained.

While many financial institutions, including JPMorgan, BNY Mellon and U.S. Bank, have joined FedNow in its pilot launch, others are planning to join in the coming months.

Citibank plans to join FedNow in the first quarter of 2024, a Citi spokesperson told BAN.

“With roughly two-thirds of U.S. bank accounts reached by TCH’s RTP system, we are optimistic that FedNow will help bridge the gap and bring the U.S. close to 100% ubiquity by appealing to the remaining FIs and credit unions that have not yet signed on for RTP,” the spokesperson said.

Banking software provider Jack Henry is onboarding more than 100 financial institutions to the FedNow payment rail since its July launch, the company said in its Q2 2023 earnings call.

The Fed’s push for adoption

The Fed is seeing a demand from state and local governments looking to adopt FedNow payments for multiple use cases, FedNow’s Baum said. State and local governments “operate a little bit like small and mid-size businesses,” and have similar payments needs to a business, he added.

Government entities can leverage FedNow for push payments along with payments acceptance, Baum said. For real-time push payments, “things like facilitated child support, collecting alimony… [and] someone doing unemployment” filings can be good use cases for FedNow.

“On the collection side, I think that it’s easy to jump to tax collections, because that’s what a lot of government inflows are about,” Baum said. “Collections for hunting licenses and driver’s licenses” are some other use cases that can help the end user and drive adoption higher.

The U.S. Treasury Department has not commented on whether it would accept tax filings and process tax returns on FedNow, but the launch of the payment channel has given them the option to leverage the service, Baum said.

The biggest hurdle for state and local governments to adopt to FedNow is network growth and the ability to “get the banks that everyone participates with on the network.” Government entities don’t have their own payments processing unit and rely on vendors to provide such services, Baum explained.

Getting banks and financial institutions on FedNow can help drive its adoption and use case higher, Baum said.

Many undisclosed U.S. government agencies are also looking to adopt the FedNow payments channel for faster and more efficient payments operations, Baum said.

Interoperability

As FIs are presented with two options for RTPs, adoption will increase if the systems are interoperable, Jack Henry’s Forman said.

“I do think that eventually there will be interoperability and drive better success and adoption,” Forman said. “Having to build two different rails could be timely and costly to do, versus having interoperability which will drive more adoption across the product across the solutions.”

The $587 billion U.S. Bank was a founder of TCH’s RTP and is a pilot adopter of FedNow, Alberto Casas, head of product for U.S. Bank Global Treasury Management, told BAN.

In his view, TCH’s RTP “has done a great job” in bringing a good chunk of financial institutions onto RTP channels.

With the launch of FedNow, existing payments channels won’t go away but will provide users with choice based on “required speed, certainty of payment and other attributes that customers can now take advantage of,” Casas said.

“We want our customer to send us a single instruction and based on what they want to accomplish,” Casas said. “We will determine which payment rail to leverage.”

U.S. Bank has developed an intelligent routing capability and user services platform that will enable the bank to eliminate that complexity by managing and routing to the payer’s preference based on a number of different criteria, Casas said. The bank’s payment network will ensure that the receiving bank is eligible for whatever transaction method it chooses to complete the transaction, he said.

FedNow and TCH’s RTP both use ISO 20022 messaging standards, Heman Daswani, principal consultant of payments and financial crimes mitigation at Temenos, told BAN.

According to Daswani, nearly 70% of the payments messaging formats on TCH’s RTP and FedNow are similar, which can make their interoperability easier. The issue of interoperability will be solved by technology providers and payments companies who are capable of processing transactions on both channels, he added.

In the future, the Clearing House’s RTPs and FedNow are expected to have interoperability, Casas said, but so far, no concrete conversation has progressed on that front, he added.

“Interoperability has been a conversation between these two rails for a handful of years now,” Hall said. “The way that we created our solution to serve our customer base was knowing that many banks and financial institutions would be interested in having access to both rails.”

Payments giant Fidelity National Information Services (FIS) is working to “simplify origination between the two payment schemes,” Meghan Oakes, head of enterprise payments for the Americas at FIS, told BAN.

“We see a mix of clients who want one rail versus the other as well as those that are looking to utilize both,” Oakes said. “Institutions know that if they want the widest reach they will need to offer both services.”

The Fed declined to comment as to if and when interoperability between TCH’s RTP and FedNow will come into existence.

Security

Cybersecurity will always be a concern for payments and FIs, even FedNow, Hall said.

“Fraudsters are always going to try to figure out a better way to do their fraudulent activity. And I don’t think FedNow is any different,” Hall said. “They’re not immune to fraud. Fraud happens on every payment method that’s out there.”

In the RTP landscape, cybersecurity is essential in order to stop illicit activities quickly, Stuart Cook, chief innovation officer at Wayne, N.J.-based Valley Bank, told BAN.

The $64 billion Valley Bank is working to create a network of banks with True Digital, a fintech marketplace, to help banks upgrade their tech stack.

“I’m anticipating there will be a really good use case [a network of banks] for authorized pushed payments as banks start adopting real-time payments and FedNow,” Cook said. “There isn’t really a solution in play at the moment for authorized push payments.”

“That actually is the largest fraud category in the U.K., which adopted faster payments, and it’s where all the fraud is. It’s hard to solve for. And honestly, the way it will be solved is through is through a network effect.”

Cross-border

While FedNow has been live for just over a month, financial institutions are already eyeing its use case for cross-border payments, according to industry experts.

FedNow “is mainly for domestic in the first scope, but as it becomes more adopted, then use cases [will] evolve to cross-border payments as well,” Daswani said.

ACI Worldwide is seeing that many businesses in the U.S. have cross-border operations that are building things here and shipping out, Hall said. U.S. businesses also have the flip side of buying from other countries and ACI Worldwide aims to provide real-time payments to such businesses, Hall said.

“It’s something that I think is going to come in the future, but we have more to do on the adoption front,” Hall said. “There’s definitely a conversation to be had on how we expand cross-border from a business perspective.”

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